Estate Seeks Redetermination of $7.8 Million Tax Deficiency

ESTATE OF LOIS HORVITZ, DECEASED, MICHAEL HORVITZ, EXECUTOR
Petitioner,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.

UNITED STATES TAX COURT

PETITION

The Estate of Lois Horvitz (“Petitioner”), through its Executor, Michael Horvitz, hereby petitions for a redetermination of the deficiency set forth by the Commissioner of Internal Revenue (the “Commissioner”) in the Notice of Deficiency dated August 20, 2019. As the basis for this proceeding, Petitioner alleges as follows:

1. Petitioner is an estate being administered under the laws of the State of Ohio and its mailing address is c/o Parkland Management Company, 1100 Superior Avenue, Suite 1105, Cleveland, Ohio 44114. Petitioner filed its Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, with the Office of the Internal Revenue Service at Cincinnati, Ohio, on or about October 18, 2016.

2. The Notice of Deficiency was issued by the Office of the Internal Revenue Service in Cincinnati, Ohio, and was mailed to Petitioner at its former address (c/o Parkland Management Company, 1001 Lakeside Avenue, Suite 900, Cleveland, Ohio 44114) on August 20, 2019. A copy of the Notice of Deficiency, including so much of the statement and schedules accompanying such Notice as is material and redacted in accordance with Rule 27 of the Rules of this Court, is attached and marked “Exhibit A.” Petitioner is separately submitting a Statement of Taxpayer Identification Number.

3. The Commissioner asserted a deficiency in estate taxes in the amount of $7,808,421, which is in dispute to the extent set forth in Paragraph 4 hereof.

4. The Commissioner's determination of liability set forth in the Notice of Deficiency is based on the following errors:

a. Administration Deduction Errors

i. The Commissioner incorrectly disallowed $183,571 of deductions attributable to investment management fees paid by the estate (Schedule J, Items 4, 13, and 81).

ii. The Commissioner incorrectly disallowed $1,581,385 of deductions attributable to fees paid by the estate for various estate administration services (Schedule J, Items 5, 14, and 82).

iii. The Commissioner incorrectly disallowed $6,979 of deductions attributable to shipping, conference call, and travel costs of the estate (Schedule J, Items 15, 83, and 84).

iv. The Commissioner incorrectly disallowed a $10,403 deduction for the cost of the reception held in connection with the funeral service (Schedule J, Item 2).

v. The Commissioner incorrectly disallowed $117,274 of deductions attributable to employee compensation (Schedule J, Items 36, 48, 62, and 67).

vi. The Commissioner incorrectly disallowed $44,374 of the deduction listed at Schedule J, Item 57, attributable to the costs of selling real property of the estate. Petitioner is also entitled to an additional $78,599 deduction attributable to the costs of selling real property of the estate.

vii. In addition, Petitioner is entitled to additional deductions for legal fees in an amount to be proven.

b. Charitable Deduction Errors. The Commissioner incorrectly disallowed charitable contribution deductions in the amount of $21,147,768 on Schedule O and made a related erroneous adjustment regarding the allocation of Federal estate taxes (Schedule O, Items 2, 3, 4, and 4a).

5. The facts upon which Petitioner relies, as the basis of its case, are as follows:

a. Administration Expenses. The administration expenses disallowed by the Commissioner were reasonable and necessary expenses for the administration of decedent's estate and properly deductible under Internal Revenue Code (the “Code”) section 2053. Each of the amounts deducted and described below represent amounts actually paid to administer the estate over a period of less than two years, which is a reasonable administrative period for an estate of this size. All of the deducted costs were incurred in connection with the administration of assets included in the gross estate and were allowable under Ohio law. Substantiation for all of these deductions was provided to Respondent. Additional facts in support of these deductions are as follows:

i. Items J-4 ($3,888), J-13 ($157,663), and J-81 ($22,020) were reasonable and necessary expenses paid to Parkland Management Company (“Parkland”) for the preservation and maintenance of the financial property of the gross estate.

A. Parkland is the Horvitz family office.

B. Parkland provided investment management services to the estate, including investment analysis and recommendations, cash planning and forecasting, investment policy development, asset allocation modeling, review of subscription documents, and similar services.

C. Parkland charged reasonable fees for the services rendered.

D. Respondent failed to give credence to the substantiation of these expenses provided by the estate. Moreover, he erroneously claimed that expenses incurred in maintaining property not subject to claims could not be deducted.

ii. Items J-5 ($8,564), J-14 ($985,021), and J-82 ($587,800) were reasonable and necessary expenses paid to Parkland for services provided to the Executor in connection with his administration of the gross estate.

A. During the life of the decedent (“Lois”), Parkland provided her with assistance managing her real estate, paying her personal bills, hiring and supervising employees and contractors, obtaining insurance, and complying with her tax obligations.

B. Given Parkland's service history and expertise related to Lois's assets and obligations, it was uniquely qualified to continue providing similar services to the estate.

C. The Executor declined to take a commission.

D. The Executor engaged Parkland to assist him in key administrative functions such as marshalling assets, paying bills, coordinating the appraisal of estate assets, gathering supporting documentation for the estate's tax returns, and supervising the maintenance and sale of real estate.

E. For these services, Parkland charged the estate its customary rate.

F. Respondent failed to give credence to the substantiation of these expenses provided by the estate. Respondent also attempted to limit the allowance of Parkland's fees to the amount allowed under Ohio law as executor's commissions, a statute entirely irrelevant to the proper allowance for administrative services. Finally, Respondent erroneously claimed that expenses incurred in administering property not subject to claims could not properly be deducted.

iii. Items J-15 ($813), J-83 ($1,309), and J-84 ($4,857) were reasonable and necessary expenses for shipping costs, conference calls, and travel incurred in the administration of the estate.

A. Respondent gave no explanation for his denial of these costs. He apparently denied these deductions simply because they were originally paid by Parkland and then reimbursed by the estate.

iv. Item J-2 ($10,403) reflects the reasonable and necessary cost of providing a reception in connection with Lois's funeral.

A. The reception took place immediately after the ceremony and was attended by the hundreds of family and friends who also attended the funeral ceremony.

B. The purpose of the luncheon was to eulogize Lois, celebrate her life, and commemorate her laying to rest.

C. Under Ohio law, the costs of such a reception are included in the “funeral expenses” to be paid or reimbursed by the Executor from the probate estate. See In re Estate of Kathy M. Campbell, 2013 Ohio 1356, 989 N.E.2d 1090, 1093 (Ct. App. 2013).

D. Although Respondent was provided with an itemized receipt for all costs of the luncheon, Respondent denied the deduction on the grounds that funeral luncheons are never deductible funeral expenses. In support, Respondent cited Davenport v. Commissioner, T.C. Memo. 2006-215, at *38, a case that interprets Michigan (not Ohio) law and also expressly states that if an estate establishes the “reasonableness” of expenditures for a funeral luncheon, as well as “the requisite necessity in connection with decedent's funeral,” the deduction will be allowed.

v. Items J-36 ($7,163), J-48 ($35,934), J-62 ($40,528), and J-67 ($33,649) are reasonable and necessary employee-related expenses for property caretakers.

A. It was necessary to maintain, preserve, and safeguard the estate's real property (and related tangible items) in California and Ohio until they could be sold or distributed in accordance with Lois's estate plan.

B. During her lifetime, Lois hired domestic employees to provide these services.

C. None of the employees were related to Lois or natural objects of her bounty.

D. The Executor reasonably determined that the domestic employees who had assisted with the maintenance, preservation, and safeguarding of Lois's property during her lifetime were uniquely qualified to continue providing these services to the estate and that laying off these employees and hiring other, third-party caretakers would be less efficient and more expensive.

E. To induce Lois's domestic employees to remain in the employ of the estate, the Executor reasonably determined that the continuation of the benefits provided by Lois, as well as an assurance of severance pay upon the sale or distribution of the properties, was necessary and appropriate.

F. The compensation expenses of retaining these employees' services are deductible under Revenue Ruling 56-604, 1956-2 C.B. 601 (1956).

vi. $44,374 of the deduction at Item J-57 reflects reasonable and necessary costs incurred in selling two parcels of real property owned by the estate in Lyndhurst, Ohio.

A. The Petitioner is also entitled to claim an additional $78,599 deduction for the reasonable and necessary costs of sale of the estate's real property in Indian Wells, California.

B. The sale of real property was necessary to generate sufficient liquidity in the estate to pay the decedent's debts, expenses of administration, and taxes, plus pay all specific bequests in the decedent's estate plan.

C. The sales were thus necessary to distribute the estate.

D. Respondent failed to consider the calculations the estate provided to this effect, claiming that because the sales were not necessary to pay “debts, expenses and taxes,” the deductions should be denied. Respondent's analysis fails to account for Treasury Regulation section 20.2053-3(d)(2), which expressly allows a deduction for the expenses of a sale “necessary in order to pay the decedent's debts, expenses of administration, or taxes, to preserve the estate, or to effect distribution” (emphasis added).

vii. The Petitioner is also entitled to claim an additional deduction for attorneys' fees. As of the date of the filing of the Form 706, Petitioner had incurred and paid legal fees and costs in the amount of $184,899. From the time of the filing of the Form 706 to the filing of this Petition, Petitioner has incurred and paid additional legal fees and costs, and will continue to incur and pay additional legal fees and costs by the time this matter is resolved and the estate is closed. The attorneys' fees and costs, in such amounts as may be proven, meet all requirements for deductibility set forth at Code section 2053 and the regulations thereunder.

b. Facts Related to Denial of Charitable Deduction

i. Lois was the surviving spouse of Harry R. Horvitz (“Harry”).

ii. Charity was important to Harry, Lois, and their children. Harry and his children founded the HRH Family Foundation, which made grants to educational, cultural, and social service organizations and provided college scholarships to individuals who demonstrated financial need. Harry served on the board or trusteed various charitable organizations such as the Montefiore Home for the Elderly, the organization now known as the Achievement Center for Children, and Lorain Community College. He also contributed to or volunteered with many area non-profit organizations. Lois and their children continued the family's charitable work after Harry's death.

iii. Upon his death, Harry's revocable trust (the “1971 Agreement”) established two qualified terminable interest property trusts (the “1971 QTIP Trusts”) for the sole benefit of Lois during her lifetime.

iv. The 1971 Agreement authorized the Trustees of the 1971 QTIP Trusts to “pay to or apply for the benefit of Lois so much or all of the principal of the [QTIP trusts] as the Trustee, in its sole discretion, deems necessary or desirable for her support, maintenance, health, comfort or general welfare, including, without limitation, for any medical emergency.” In making such distributions, the Trustees were not required to “inquire into or take into consideration any other . . . sources of income or support” available to Lois.

v. The 1971 Agreement expressly authorized the Trustees of the 1971 QTIP Trusts to “make transfers that serve estate or tax planning objectives” of Lois.

vi. The 1971 Agreement contained a number of other provisions designed to provide Lois and the trustees with broad authority over the 1971 QTIP Trusts. The 1971 Agreement granted Lois withdrawal powers, gave the trustees the authority to terminate the trust and distribute all assets to Lois, and granted Lois the controlling vote on all trustee decisions (including whether to make distributions to herself). All of these provisions — like the decanting provision discussed below — gave Lois and/or the trustees the power to override the default beneficiaries of the 1971 QTIP Trusts.

vii. The 1971 Agreement granted Lois a limited testamentary power of appointment over the residues of the 1971 QTIP Trusts exercisable in favor of Harry's descendants by express reference to the relevant provision in her Will.

viii. On May 7, 2013, the Trustees of the 1971 QTIP Trusts distributed all of the principal of the 1971 QTIP Trusts to new trusts (the “2013 QTIP Trusts”) governed by a trust agreement dated February 2, 2013 and styled the “HRH QTIP Trust” (the “2013 Agreement”). This distribution is referred to herein as the “Decanting.”

ix. The 2013 QTIP Trusts were held for the sole benefit of Lois during her lifetime.

x. The 2013 Agreement granted Lois an expanded testamentary power of appointment over the residues of the 2013 QTIP Trusts, exercisable in favor of Harry's descendants and/or charities, by express reference to this provision in her Will, or by a signed and witnessed instrument taking effect upon her death and delivered to the Trustee during Lois' life.,

xi. Consistently with Harry's wishes as expressed in the 1971 Agreement, the Decanting was undertaken to enable Lois to fulfill her estate planning goal of leaving additional assets to charity.

xii. Article THIRD B of the 1971 Agreement states that “[a]n authorization to apply principal to or for the benefit of a beneficiary shall include authority to pay principal to a trust for the benefit of that beneficiary. . . .”

xiii. The Decanting complied with the requirements of Article THIRD B of the 1971 Agreement.

xiv. The Decanting was authorized by Article THIRD B of the 1971 Agreement.

xv. Ohio statute also authorizes the decanting of trusts. Ohio Revised Code section 5808.18(A)(1) authorizes the trustee of a trust who has “absolute power . . . to make distributions of principal” to “exercise that power by distributing all or any part of the principal . . . to the trustee of another trust . . . that is for the benefit of one or more current beneficiaries of the first trust.”

xvi. Ohio Revised Code section 5808.18(A)(2)(b) states that “[a] power to make distributions of principal for purposes that include . . . welfare, comfort . . ., or words of similar import, if not otherwise limited by reasonably definite standards or ascertainable standards, constitutes an absolute power.”

xvii. As defined by the Ohio statute, the Trustees of the 1971 QTIP Trusts had “absolute power . . . to make distributions of principal” to Lois.

xviii. Ohio Revised Code section 5808.18(A)(3)(a) expressly states that the recipient trust in a decanting may “[g]rant a power of appointment to one or more of the beneficiaries . . ., including a power to appoint trust property to . . . any other person, whether or not that person is a beneficiary of the first trust or the second trust.”

xix. Nothing in the 1971 Agreement expressly prevented the Decanting. Specifically, nothing prevented the expansion of Lois's power of appointment to include charities, or the ability to exercise the power by a signed and witnessed instrument taking effect upon her death (rather than only by will).

xx. The Decanting complied with the requirements of Ohio Revised Code section 5808.18.

xxi. The Decanting was authorized by Ohio Revised Code section 5808.18.

xxii. Despite the express authorization of the Decanting both in the 1971 Agreement instrument and under the Ohio statute, Respondent claims that the Decanting was unauthorized.

xxiii. On May 13, 2013, Lois executed a revocable signed and witnessed instrument directing that the residue of the 2013 QTIP Trusts (over $21 million) be distributed to three private foundations established by the Horvitz children: the PAH Foundation, the MJH Foundation, and the PTS Foundation (each a “Foundation” and, together, the “Foundations”).

xxiv. Lois died on July 23, 2015, without revoking the exercise of her power of appointment.

xxv. The assets of the 2013 QTIP Trusts were included in Lois's gross estate pursuant to Code section 2044.

xxvi. On December 8, 2017, the 2013 QTIP Trusts distributed $3,393,571.51 to each of the Foundations.

xxvii. The remaining assets in the 2013 QTIP Trusts are being held in reserve by the trustees. All remaining assets of the 2013 QTIP Trusts (after payment of estate taxes and administrative expenses) will be distributed in equal shares to the Foundations.

xxviii. Each of the Foundations is a charitable organization contributions to which are deductible for federal income tax and federal estate tax purposes.

xxix. Respondent seeks to deny a charitable deduction for the distributions from the 2013 QTIP Trusts to the Foundations, despite the fact that the distributions were made in full compliance with Harry's estate plan, Lois's estate plan, the terms of all relevant instruments, and Ohio law. Any additional tax paid by Lois's estate as a result of the Respondent's denial of this deduction will be borne by the Foundations and diminish the assets available for charity.

WHEREFORE, Petitioner respectfully requests that the Court grant the following relief:

a. Determine that the deficiency proposed in the Notice of Deficiency is erroneous;

b. Determine that the Respondent erred as alleged in the assignments of error set forth in Paragraph 4 herein above;

c. Determine that Petitioner owes additional tax only with respect to the adjustments not challenged herein;

d. Determine that Petitioner is entitled to additional deductions under section 2053 of the Code, in such amounts as may be proven; and

e. Grant such other and further relief to Petitioner as may be appropriate.

Dated: November 15, 2019

Respectfully submitted,

ADMITTED

CHRISTOPHER S. RIZEK
Tax Court Bar No. RC0369
CAPLIN & DRYSDALE, CHARTERED
One Thomas Circle, N.W., Suite 1100
Washington, D.C. 20005
Telephone: 202/862-8852
crizek@capdale. com

ADMITTED

BETH SHAPIRO KAUMAN
Tax Court Bar No. KB0145
CAPLIN & DRYSDALE, CHARTERED
One Thomas Circle, N.W., Suite 1100
Washington, D.C. 20005
Telephone: 202/862-5062
bkaufman@capdale.com

ADMITTED

MEGAN E. WERNKE
Tax Court Bar No. WM0603
CAPLIN & DRYSDALE, CHARTERED
One Thomas Circle, N.W., Suite 1100
Washington, D.C. 20005
Telephone: 202/862-5088
mwernke@capdale.com

Attorneys for Petitioner